Each of the five types of business unit has its own management issues. Conformers have performance crises at the same time as the corporation and that provides an impetus for change. Whereas Amplifiers have problems that come to the fore in times of poor performance and hence receive a significant amount of corporate management attention, perhaps too much.
“Amplifiers will have big ups and downs, so when they are down they are really down, but these are the crises you need to induce change,” says Donaldson. “But they are a problem to the head office, which may spend a lot of time worrying about them, because of the instability of their performance returns. But if you go to the Counter-Cyclicals – which in the case of CSX was a commodity like export coking coal – they will probably have enough fluctuations to have serious downturns, but when they are down the rest of the corporation is up, so head office may be relaxed about them.”
Donaldson suggests that this analysis can deliver fresh insights into the dynamics of a corporation and a different understanding of its behaviour. The analysis also suggests a new approach to managing corporate risk.
“If you want to reduce corporate risk, you can focus on decreasing your Amplifiers and increasing your Counter-Cyclicals and Stabilisers in the short term by divestment and acquisition,” he says. “In the longer-term, you can allocate your capital to shrink your Amplifiers and grow your Counter-Cyclicals and Stabilisers. And, of course, if you want to increase your corporate risk, which in some circumstances can be appropriate, do the converse.”
Against the grain
The use of this approach can sometimes deliver conclusions that go against conventional business thinking. Donaldson used this methodology when he looked at the de-merger of Australian building products company CSR, which removed the long-standing sugar business from the company’s portfolio.
“We are all taught that firms should diversify because diversification is the thing that reduces risk,” he says. “But when we looked at CSR, we saw that diversification was having the opposite effect. Having sugar in the CSR portfolio, instead of reducing the risk, actually increased the risk of the organisation as a whole, and that goes against the whole idea of diversification as risk reducer.”
Using OPA on CSR showed that the sugar division operated as an Amplifier within the company. The sugar division has a risk that is high and is synchronised with corporate risk, making it an Amplifier that boosts CSR’s profit volatility.
“Amplifiers actually increase risk, so taking sugar out of CSR reduced the overall risk at that company,” says Donaldson. “So if you want to reduce risk, think about divesting an Amplifier, or switching your asset allocation out of business units that are Amplifiers and into other business units.”
Risk is not always a bad thing, and OPA shows how managing the risk internally can be a driver for profitability. Take the case of IBM:
“If you want to increase the value of the corporation, you could decrease low profit-to-risk business units, such as hardware, by divestment,” says Donaldson. “Or you might – and you can do this at the same time – acquire some high profit-to-risk business units, such as software.”
Donaldson believes OPA is a significant new business tool for managing risk. Through OPA, businesses can identify the risk type of each of their business units, a process that can help in diagnosing what needs to be done in any organisational redesign.
“I believe it can enhance the understanding of the sources of corporate risk,” he says. “And through this process comes an understanding of how corporate risk can be altered and economic value can be created, and I think that is a superior insight to the conventional focus on diversification. I think we are really breaking some new ground with this.”
